Obama's bank regulation: Doomed to fail?

When Barack Obama donned the crusader's mantle during the 2008 presidential campaign, his web-savvy campaign team created KeatingEconomics.com and pushed it on millions of voters. The main video showed Charles Keating—the wealthy, politically connected poster child of the '80s savings-and-loan scandal—in handcuffs.

The Obama video portrayed John McCain as Keating's stooge and likened the S&L crash to the 2008 Wall Street meltdown, which was even bigger and badder. Today's corporate villains were flashed on the screen, among them AIG, Bear Stearns, Lehman Brothers, and Fannie Mae. The opening narrator was Bill Black, a Ph.D. criminologist and lead lawyer at the Office of Thrift Supervision, who helped steer the brilliant federal effort that cleaned up the S&L industry and won more than 1,000 felony convictions of senior insiders while recovering millions of their ill-gotten dollars.

Those watching the compelling attack ad had every reason to believe that Obama's approach would be just as hard-edged, and that felon-busting G-men would rout the crooks and recover our money.

That was not to be.

As it stands now, only one federal prosecution is related to the credit crash and massive federal bailout, and it was begun by the Bush administration's Justice Department in June 2008.

Not that there aren't culprits. Wall Street's institutional buccaneers carted off up to $12.7 trillion—almost the size of the entire gross domestic product. Today's pirates are sailing away from the light regulatory scrutiny that apparently will continue in our benighted, weakened, and bubble-addicted economy.

Black says that Obama's current efforts are doomed to fail—and, in a twist, it's for lack of trying. "There is not a single successful regulator giving him advice," says Black. He pointedly views Treasury Secretary Tim Geithner and SEC Chair Mary Schapiro as flops in the prelude to the crisis, who flacked for the financial industry's "self-regulation." Some of Obama's appointees have a history as ardent advocates for financial crooks and active foes of regulation. Because neither the Obama team nor its proposed reforms pack the requisite punch, Black predicts, "There will be far more catastrophic losses."

Still, all hope for justice is not lost. Scammed consumers could get their day in court, thanks to a Supreme Court decision this past June in Cuomo v. Clearing House Association, which ruled that the federal government cannot stop states from conducting their own crackdowns on financial crooks—with more stringent laws than Washington's—against such evils as the predatory mortgage lending that sparked last fall's meltdown.

In that case, the Obama administration shed its crusader's mantle and defended the dark side—but in vain.

CONCEIVABLY, SOME OF THE MONEY RIPPED off by financial institutions in their orgy of trading and selling bad investments could be "clawed back," in the parlance of regulators. The best way to retrieve at least a portion of that wealth is through prosecution, followed by forfeiture. This is what we do when we catch money launderers and drug lords, or Ponzi schemers like Bernie Madoff. It's retributive justice. It fills a social need as well as an economic one.

So, where is the justice in the current crisis? Why have there been so few prosecutions and only feeble attempts to claw the money back? One reason may be that, in such infamous cases as the Lehman Brothers collapse and Bank of America's absorption of Merrill Lynch, the Fed and the Treasury were intimately involved with the financial elite's deal-making at the time. It's difficult to prosecute others for securities fraud if you condoned the deals to begin with.

And there's another, more pertinent reason: The top federal law enforcement establishment is simply not in the mood. People who expect President Obama's Department of Justice to take the lead will be severely disappointed, because the Obama administration is showing that it lacks the will. Instead, the new administration is putting its energy into creating what it believes will be a meltdown-proof new system of elite, "too big to fail" banks, regulated by a beefed-up Federal Reserve.

Bill Black calls that elite group of megabanks, like Citigroup and Bank of America, "zombies." And they're not done feeding. All of the devilish tools remain in place, says Black, including "the subprime loans, with securitization and the credit default swaps. And the Obama administration astonishingly wants to re-create a secondary market in subprime loans—even though it cost us more than a trillion dollars."

More important, the nation's new top prosecutor, Attorney General Eric Holder, has a history of preferring that deviant corporations be held to no more than a "voluntary cooperation" system in which they investigate themselves privately.

Under the "Holder Memo," which he wrote in 1999 as deputy AG in the Clinton administration, bad-boy executives and their corporations who turn over evidence to the government qualify for lenient sentences and fines and, sometimes, for settlements without even indictments. The consequences of their crimes often amount to only the cost of doing business.

After leaving government, Holder followed the mandates of his own memo and made a lucrative living conducting internal probes for companies and negotiating outstanding results for white-collar clients. He was public about it: Holder's 2002 op-ed "Don't Indict WorldCom" in TheWall Street Journal argued on behalf of the corporate perpetrator of one of the sleaziest frauds of the past decade.

When asked if he plans to prosecute the financial mayhem that erupted under Bush, Holder has said he isn't inclined to engage in what he calls "witch hunts."

Last spring, Holder tabbed Lanny Breuer, his former partner at the major D.C. law firm Covington & Burling, to head the DOJ's Criminal Division. Breuer couldn't be further from the right person to root out white-collar crime.

As chief of Covington's white-collar department, Breuer was known for his "rogues gallery" of corporations and individuals under investigation or indictment. His clients included Halliburton, the Federal Home Loan Mortgage Corporation (Freddie Mac), Exxon Mobil, and big pharmaceutical companies.

Breuer's former work with Freddie Mac is especially troubling. One of the executives at the heart of the global meltdown was Franklin Raines, the CEO of Freddie's older sister, the Federal National Mortgage Association (Fannie Mae). Freddie and Fannie bought and securitized mortgages from other banks at a breakneck pace that fueled the bubble and led to their federal bailouts and takeovers in September 2008. An investigation of Fannie and Raines's practices could spread to Freddie, which is not something Breuer or any other lawyer would want for a former client.

Obama played the populism card during the campaign, making fodder of Countrywide, then the nation's largest mortgage company and a dominant player in the subprime scandal: "These are the folks who are responsible for infecting the economy and helping to create a home foreclosure crisis—two million people may end up losing their homes." We are, in fact, north of three million, and the widely expected criminal prosecution of Angelo Mozilo, Countrywide's chief during the heyday of predatory home loans, hasn't materialized. Mozilo's case was merely channeled to the SEC for civil sanctions.

The SEC accused Mozilo and two top aides of selling $140 million in stock based on inside knowledge of the riskiness of credit that Countrywide extended while it told investors that the loans were secure. A Mozilo email called one subprime loan "the most dangerous product in existence.... There can be nothing more toxic," and another "poison." It would seem as if a criminal securities fraud case could be made against Mozilo and his crew. The Justice Department wouldn't confirm or deny pending indictments, but Mozilo is probably safe. Usually, when there's going to be a prosecution, the SEC refers the case to the DOJ and doesn't press it alone.

You would think that AIG's Joseph Cassano would also be prosecuted for securities fraud. As boss of AIG Financial Products, Cassano made ungodly amounts of money by selling credit default swaps (CDSs), which were side bets on collateralized debt obligations (CDOs) swelled to the gills with subprime-mortgage toxins. In fact, the AIG arm sold so many credit default swaps that it lost track of the number, but they totaled more than the value of AIG itself, which was one of the world's biggest companies. The ensuing collateral calls to satisfy the deals choked AIG nearly to death, triggered the financial crisis of September 2008, and led to the biggest bailout of all: $182.5 billion to keep AIG afloat as an 80 percent government-owned company.

A grand jury was reportedly convened to look at Cassano. The DOJ won't confirm or deny the existence of a probe, but given the remarks of Cassano's lawyer, F. Joseph Warin, in September, the grand jury probably exists. Warin said that his client was cooperating and that AIG had known about all of Cassano's deeds. Will the Justice Department seek to indict AIG's leadership? No comment.

In fact, there seems to be little going on in the justice process. Elite white-collar defense attorneys report no clamor for their counsel from major financial managers. Regulators talk of no demand for their services and for evidence from prosecutors. As they say in the trade, there's no "buzz."

SO FAR, THEN, THE COMMON PERSON HAS reaped little relief. Well, maybe clearer credit card statements, plain vanilla mortgages with slightly less fine print, and probably some "green" infrastructure jobs. But these have been slow to happen. About a billion dollars have been dedicated to putting and keeping "cops on the street." Remember the poignant vignette during the State of the Union address in which Obama talked about saving 57 police jobs in Minneapolis? But keeping the public safe from financial criminals is another story: The administration and Congress have failed to bulk up white-collar fraud enforcement with either new FBI agents or new forensic specialists.

That annoys the hell out of proven financial-crime fighter Bill Black. Athletic and red-bearded, Black looks more like a lumberjack than a scholar, criminologist, and bureaucrat who, in 2005, authored The Best Way to Rob a Bank Is to Own One, the definitive history of the S&L debacle. A legend among regulators, he faced down House Speaker Jim Wright and the "Keating Five" senators (including McCain), who fought tooth and nail to protect that corrupt industry, and he overcame stiff resistance from within the Reagan administration.

Black always has a big smile and a ready joke, but he burns with the intensity of an Old Testament prophet, especially against "control fraud," the lawlessness that emanates from the top of legitimate businesses and causes bigger financial losses, he has said, than all other forms of property crime combined. Corporations practice control frauds with crooked accounting and perverse compensation systems, using bonus formulas that lead executives to loot their companies rather than serve them.

Now an associate professor of law and economics at the University of Missouri at Kansas City, Black has continued the fight against fraud and for regulatory controls as a consultant to a gamut of agencies from the FBI to the World Bank.

In 2007, the Office of Federal Housing Enterprise Oversight hired him to investigate the problems at Fannie Mae. His 70-page report plainly outlined how Raines and his lieutenants used "fraudulent accounting" and "perverse incentives" and took "unsafe and unsound risks" that "collectively caused Fannie to violate the law and deceive its investors and regulators."

Almost two years before the financial crisis broke in late 2008, Black, the FBI, and others outlined the structural problems that would wreck the economy, but Washington did nothing and continued to exercise "regulatory forbearance."

Black vents particular ire at Tim Geithner, who, as New York Fed chair, fiddled while Wall Street imploded; Henry Paulson and Geithner again, who, as Treasury secretaries, refused to enforce a key banking law; and Alan Greenspan and Ben Bernanke, who, as Fed chairs, were supposed to regulate banks, especially the renegade mortgage units. The two Fed chairs closed their eyes to excess and continued to blow easy money into the bubble.

The key statute that Treasury flouted under Paulson and Geithner is the Prompt Corrective Action (PCA) law. Congress passed it in the wake of the S&L scandal in 1991, and the first President Bush signed it. It's probably the best, fairest, and clearest piece of financial legislation since the New Deal. Under the law, Federal Deposit Insurance Corporation (FDIC) examiners initially rate banks as "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." The tags determine the examiners' actions, if any. Undercapitalized banks must build up their capital and get FDIC approval for acquisitions and opening new business lines. When a bank becomes significantly undercapitalized, a regulator can order serious sanctions, ranging from firing management to restricting stock sales and forcing divestitures. Critically undercapitalized banks must be placed in receivership, unless the FDIC determines that some other action like a merger or sale would better protect the depositors.

The PCA worked like a charm. During the entrepreneurial Reagan-Bush era, the banking system had become a mess. Often more than a hundred banks failed annually, as will happen this year (as has happened this year). After the PCA, banks cleaned up and failures became rare—only a handful per year and sometimes none.

But after the second Bush's election in 2000, the PCA began to wither from disuse, especially because of opposition from the megabanks and the laissez-faire policymakers. Toward the end of the Clinton administration, Washington caved in to the financial lobby and passed new laws that promoted risk. Congress repealed the Depression-era Glass-Steagall Act, which had drawn a sharp line between commercial banks and investment banks. Another new law immunized securitizers from lawsuits even if their products were rubbish. A third allowed the wildest form of derivatives—"naked" credit default swaps, which are side bets on CDOs that could be placed by investors who didn't even own the bonds. The old prudent conservative banking model gave way to the sleek megabank casino. The message from the Bush administration was clear: The PCA "ceased to be applied to the big boys," says Camden Fine, president of the Independent Community Bankers of America. With his square jaw and plainspokenness, Fine calls to mind Jimmy Stewart in It's a Wonderful Life. Like Stewart's George Bailey, Fine is a small-town banker, though now he is the sole lobbyist for about 5,000 member banks around the United States.

Fine says he can live with the PCA law and even endorses it, but he detests that it was no longer being used for the megabanks. "Greenspan—banks couldn't get too big for him," Fine says ruefully. He recalls a 2004 battle in which the Fed wanted to remove all capital-reserve requirements from the big banks. Fortunately, the FDIC won that scrum. Otherwise, the megabanks' behavior could have been even riskier and more devastating than what occurred. Eventually, it became clear that "nothing was happening to the big banks, and everyone knew they were sliding south," says Fine. Major banks like Wachovia, National City, Bank of America, and Citigroup became critically undercapitalized, but regulators did nothing.

Recently, Paul Volcker, the former Fed head and current Obama adviser, indicated that the White House remains committed to the concept of "too big to fail," meaning that the megabanks will continue to have a safety net and may ask for more bailouts. Presently, 19 financial institutions are on the protected list. Their business model hasn't changed materially since the crisis. They're still bloated and addicted to gambling.

WASHINGTON MAY VERY WELL FOIST ONE unified regulator on the industry, a consolidation that, at first glance, could seem like a good idea. The Big Four banks—Citi, B of A, Wells Fargo, and JP Morgan Chase—now control about 53 percent of all bank assets; the biggest 20 banks control 80 percent. There's no denying the appeal of a Transformers-type battle between a heroic Autobot regulator and the financial world's Decepticons. But that's make-believe.

The cyclops theory of bank regulation that would fuse all four bank regulators into one "superagency" is the heart of a bill by Sen. Chris Dodd. Other proposals have been floated by the administration and Barney Frank, chair of the House Financial Services Committee.

Fine is concerned about such a monolithic regulator, saying the big boys would be able to influence it more easily than they can the current mélange of the Fed, FDIC, Office of the Comptroller of the Currency, and Office of Thrift Supervision. But the structure of such a new beast is far from set.

For instance, Dodd wants the Fed to lose its regulatory hold over banking and consumers (especially credit cards). Conversely, the Obama administration strives to make the Fed the über-regulator of banks and "shadow banks"—non-depository units like Countrywide and GE Capital.

But the idea of Super Fed as top financial cop as well as the nation's central bank is colossal and colossally bad. The Fed chair is, by law, independent and doesn't answer to the president or Congress. A lax chief—and there's every reason to expect him or her to be lax considering the cheek-by-jowl closeness of the Fed to banking and finance magnates, and the baleful history of Fed enforcement—could not be simply removed. Fed Chairman Bernanke, for example, is an academic economist with no enforcement or justice chops.

The Fed's obsession with secrecy is another major problem. Take Congressman Ron Paul's popular bill to subject the central bank to audits like every other federal financial agency. The Fed pushed back hard against that proposal. Even when Geithner—himself a former New York Fed chief—asked for a public review of the Fed's murky governance and structure, the secretive agency declined.

In August, a federal judge granted a Freedom of Information Act request by Bloomberg News to reveal the identities of banks that borrowed from 10 Federal Reserve programs during the peak of the financial crisis last fall. The Fed claimed the material was confidential and would hurt the banks' "competitive position." Is this the agency we want protecting the public?

ALL HOPE IS NOT LOST. THE ADMINISTRATION and congressional Democrats do support a promising reform called the Consumer Financial Regulatory Agency (CFRA). Obama's 80-plus-page proposal contains yawning gaps that Congress may fill and the financial industry will fight: Insurance isn't covered, nor are 401(k) retirement plans, and the majority of financial consultants and planners (including all the mini-Madoffs out there) evade scrutiny and standards. But the CFRA would wrest consumer-protection powers away from the Fed, which has them now and has failed consumers utterly.

Critically, a CFRA could allow scammed consumers to go to court against the securities industry. This is major. And, of course, it is a bridge too far for the financial industry. Its lobby has won every major legislative battle in the past 20 years. Wall Street's lobbyists and their congressional allies can be expected to call in all their markers to ensure that securities-fraud and other financial-crimes cases won't be heard in front of hometown juries.

There's something more encouraging: The CFRA, at least as now envisioned, would be a model of financial federalism, allowing states to pass even more stringent protections. The money lobby will have more trouble beating down this reform because of the Supreme Court's Cuomo v. Clearing House Association decision. Though it carries the name of the current New York attorney general, the 5-4 opinion last summer amounts to a last big regulatory gift to consumers from former New York AG Eliot Spitzer, who tried to probe the big national banks about whether their credit interest rates for racial minorities were ratcheted up. The Bush administration sued to block New York from enforcing its laws on national banks, a posture strangely continued by Obama's lawyers. But the high court's four liberals, plus usually arch-conservative business ally Antonin Scalia, collaborated on the decision, which could give the go-ahead to states to pursue big-time financial criminals even if the federal government won't.

Too big to contain, probably, are the derivatives, especially the synthetic (also known as naked) CDS that crashed us last fall. Warren Buffett, among others, thinks this financial plutonium can't be controlled and should be outlawed, as it was until 2000. But a new ban may already be off the table. Barney Frank, usually the most avid reformer on derivatives, pointedly left out a ban on naked CDS deals in the proposal he submitted in early October. The Obama team wants default swaps cleared by a "central counterparty"—in other words, on a public exchange. That way, we're told, if the slaughter starts, we'll see it and stop trading before it's too late.

It's not enough. Naked swaps are the equivalent of financial gang rape. As soon as hedge funds, investment banks, and big-time short sellers sense that a bond is flailing, they can pile on with as many derivatives as they like to make millions in what are, in effect, side bets in a craps game. Today, electronic trades take five milliseconds, according to the New York Stock Exchange. The carcass will be picked clean long before any bureaucrat gets regulatory authority to shoo away the vultures. The central-counterparty market only applies to standard, rather than "customized," derivatives. So if you're savvy enough to put a few bells and whistles on your swap, you can still push it through the dark, digital, over-the-counter alleys, far from the gaze of prying regulators. We're just as vulnerable as we were in the dizzy days of AIG, JP Morgan, Lehman, and Bear Stearns.

The truth about naked swaps is that they're as sordid as they sound. To be clear: They're the costliest, riskiest form of gambling on Earth. Only a few economic patricians can play: hedge funds, banks, pension funds, insurance companies, and governments. But, as we learned the hard way in 2008, just about everyone, including the system itself, loses when they win.

They're not getting better or safer. Credit is still tight as a tick. The financial industry is expanding its use of exceedingly complex derivatives. The mortgage market, the source of the raw material for mayhem, remains unchecked. The FBI said this summer that mortgage fraud is "rampant" and growing, with suspicious-activity reports (known as SARS) on a pace to exceed 70,000 in fiscal 2009, up from 63,000 in 2008 at the height of the crisis. A growing source of exploitation involves reverse mortgages marketed to the elderly.

People want justice. They've lost savings, homes (or the value of homes), jobs, and retirements. Foreclosures continue to rise. People can't believe that the mega-grifters who pulled off mortgage, securitization, and derivative frauds walk the streets with lined pockets. And the venal "experts" who issued bogus ratings that deodorized subprime cesspools should be in the dock. But it almost seems as if Bernie Madoff's 150-year sentence for a scheme that had nothing to do with Wall Street's meltdown is supposed to cover all the crooks, and that we're supposed to be satisfied.